The Reserve Bank of India (RBI) has projected an upbeat outlook for the country’s growth prospects even as it flagged risks from inflation, led by food prices, and volatile capital flows triggered by instability in international financial markets.
Emphasizing price stability as the prime focus of monetary policy, the report, released on Thursday, did not signal any easing of the tight money regime and instead said that “contextually, financial stability may assume greater importance in the months to come”.
“There is growing evidence that the economy is possibly poised on the threshold of a step-up in the growth trajectory, provided the vigil on price stability, including financial stability, is intensified in a convincing manner,” said the 2006-07 report. Economic growth in 2006-07 was 9.4%, up from 9% in the year earlier.
RBI ANNUAL REPORT 2006-07 (Text)
RBI ANNUAL REPORT (Graphic)
The central bank also underlined the importance of improving the absorptive capacity of the economy to successfully deal with excess rupee liquidity and capital flows of foreign currencies. It recommended removal of infrastructure bottlenecks, especially in the power sector, amending labour laws, additional investments in agriculture and continued fiscal restraint.
Domestic developments would be the key to determining RBI’s stance on monetary policy measures, such as interest rates, but the threat posed to financial stability by international developments is likely to be top priority in the near future.
“The central bank has clearly indicated the monetary policy will be dominated by the turn of events in the domestic market,” said Indranil Pan, senior economist at Kotak Mahindra Bank Ltd. “However, the RBI will continue to closely watch global movements...”
RBI is concerned about both the spillover of the subprime crisis that originated in the US and spread to European credit markets, and the quality of India’s foreign exchange inflows. Net foreign direct investment (FDI) inflows touched a record $19.4 billion (Rs89,240 crore then) in 2006-07, but the report cautions that while FDI inflows are considered relatively stable, the nature of recent inflows may be otherwise.
“New types of FDI flows through private equity (PE) funds and venture capital funds may not necessarily have a direct link with investment in physical assets, and could contain a volatile component at the margin,” the report said. PE and venture capital inflows made up about $6 billion of the net FDI inflows in 2006-07.
The large FDI inflows, along with overseas borrowing by Indian companies, largely led to a unidirectional movement of the rupee against the dollar from the beginning of the year until early August. Since then, the rupee has weakened against the greenback and the report cautioned companies to shield themselves against increasing volatility with suitable hedging strategies.
The annual report also made a case for the central bank to continue intervening for the sake of financial stability.
Such intervention boosts India’s attraction as an investment destination and shields exporters without the means to protect themselves against currency volatility, the report added.
Maintaining price stability was spelt out as a key aim in the wake of hardening international commodity prices, strong growth in domestic money supply and the domestic fallout of large foreign exchange inflows.
Though RBI did not clearly indicate its approach to monetary policy, it did suggest that the bank is unlikely to soften it in the near future. “The stance of monetary policy would continue to reinforce the emphasis on price stability and well-anchored inflation expectations, and thereby sustain growth momentum,” the central bank said.
RBI’s annual report has taken a dim view of the country’s agricultural prospects. “Indian agriculture is becoming increasingly unsustainable both from the point of view of overall economic progress and environmental balance,” it said.
RBI has suggested that the government maintain a moderate tax rate structure, eliminate major tax concessions and bring more services under the tax net.
(Gargi Banerjee in Mumbai contributed to this story.)